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KNOWLEDGE How do distributions work? This guide will help provide you with an understanding of different types of mutual fund distributions and how they can impact .

Distributions paid by mutual funds represent earnings generated by different types of investments held in the fund. As these investments earn income or are sold by the fund, the earnings are distributed in various ways. Depending on the source of the earnings, mutual fund distributions can have different tax implications and should be clearly understood for efficient tax planning

Contents Fundamentals of distributions 2

Types of Distributions 3

Impact of Distributions 5

ROC Distributions 11

Corporate Class Funds 13

Other Considerations 14

How do mutual fund distributions work? | June 2019 | Page 1 Distribution Fundamentals

Q: What is a distribution? Q: How are distributions calculated? A mutual fund distribution represents the earnings of Distributions are allocated to unitholders in proportion to a fund being passed on to the individual investor or the number of units they hold on a specific date, known as unitholder of the fund. the “record date”. Example: If you held 100 mutual fund units on the record Q: How often are distributions made? date, and the distribution was $0.50 per unit, you would receive a taxable distribution of $50. The frequency varies by the specific fund – distributions can be paid monthly, quarterly, or annually. Q: Are distributions made for a set amount? While some mutual funds have a target or fixed Q: Why do mutual funds make distributions? distribution, the sustainability of the fixed distribution is based on market performance. As a result, a fund may Earnings retained by a mutual fund are generally subject change the distribution amount without notice. to tax at the highest marginal rate. Distributions received by individual are taxed at their own marginal tax rates, which may be lower than the rate applicable to the fund.

Note The different types of distributions that are discussed in this guide include interest income, Canadian income, capital gains, return of capital and foreign income. Fundamentals How do mutual fund distributions work? | June 2019 | Page 2 Types of Distributions

What are the different types of distributions?

Type of distribution Definition Taxation Mutual fund type

Interest income Occurs when the fund •• Fully taxable at the •• earns income on debt same marginal tax rate •• Balanced Funds securities (e.g. treasury as ordinary income •• bills and bonds). •• Reported on your T3 •• TD Cash Flow Series tax slip (Relevé 16 •• TD Monthly Fixed in Quebec) Pay Solutions

Canadian dividend Received when a fund •• Generally eligible for •• Canadian equities income invests in shares of federal and provincial •• Balanced Funds public companies that tax credits •• Fund of Funds pay . •• Tax rates vary by •• TD Cash Flow Series province •• TD Monthly Fixed •• Reported on your T3 Pay Solutions tax slip (Relevé 16 in Quebec)

Capital Gains Generated when the •• Only 50% of the capital •• Canadian equities trading activity within gain is taxable to •• U.S. Equities a fund results in an unitholders •• Emerging Markets overall gain. •• Reported on your T3 Equities tax slip (Relevé 16 •• Balanced Funds in Quebec) •• Fund of Funds •• TD Cash Flow Series •• TD Monthly Fixed Pay Solutions

Foreign non-business Occurs when the fund •• Fully taxable at the •• U.S. Equities income receives dividends, same marginal tax rate •• Emerging Markets interest or other types of as ordinary income Equities distributions from foreign •• Reported on your T3 •• Balanced Funds investments. tax slip (Relevé 16 •• Fund of Funds in Quebec) •• TD Cash Flow Series •• TD Monthly Fixed Pay Solutions

Return of Capital (ROC) Generated when an Not taxable since it’s a •• TD Cash Flow Series investor’s original return of investor’s own •• TD Monthly Fixed amount, or invested capital (which Pay Solutions capital, being returned to has already been subject them by a mutual fund. to taxation). Reduces the Typically occurs when ACB of the fund which the fund’s objective is to typically results in bigger generate regular monthly capital gain (or smaller distributions. capital loss) when the units are sold.

How do mutual fund distributions work? | June 2019 | Page 3 Types of Distributions

How Different Distributions are Taxed: The example below shows the after tax value of $100 for the different types of mutual fund distributions:

Interest Dividends

$66 $34 $50 GIC $50

Capital Gains Return of Capital

$75 $25 Non- $100 Taxable*

*Example shown for illustrative purposes only. Tax rate assumptions (Ontario): 49.53% marginal income tax rate; 33.82% dividend income marginal tax rate; 24.77% capital gains marginal tax rate. Percentages have been rounded. As as the adjusted cost base of the investment is greater than zero. Capital gains taxes may be payable when the units of a fund are sold or to some extent when their adjusted cost base goes below zero. Return of capital (ROC) distributions do not constitute part of a fund’s or . ROC reduces the adjusted cost base of the units to which it relates. ROC is not considered taxable income as long as the adjusted cost base of the investment is greater than zero. Capital gains taxes that may be deferred when ROC distributions are received, will be payable when the units of the fund are sold or when their adjusted cost base goes below zero.

How do mutual fund distributions work? | June 2019 | Page 4 Impact of Distributions

How do distributions impact mutual funds? Distributions can affect your mutual fund in different ways. They can impact the Net Value (NAV) or price of your funds and, if re-invested, your ACB and .

Net Asset Value (NAV) represents the price of How do distributions affect the price of a fund? a mutual fund. The NAV per represents the During the year, as interest, dividend income and mutual fund’s less its liabilities and will change capital gains are accumulated in the fund, the due to fluctuations of the market value of your mutual NAV will increase. If a distribution is made, the NAV fund’s investments. A fund’s NAV is calculated daily per unit drops as the fund holds fewer assets after using the price of the securities in the mutual fund at the distribution. the market close.

Note Taxable income in an Registered Plan, such as a Retirement Savings Plan (RRSP) or a Tax Free Savings Account (TFSA) is treated differently.

An RRSP defers the tax payable on investment income for as long as the funds remain registered. Investment income in a TFSA is tax free.

Reinvested distributions do not count as contributions and therefore do not affect the contribution room for either account type

DistributionsHow do mutual fund distributions work? | June 2019 | Page 5 Impact of Distributions

Impact of distributions: 2 ways to receive a distribution

100 units purchased at $10/unit $1000 The following example shows the difference between receiving the distribution in cash versus being reinvested to purchase Initial Purchase additional units

•• NAV increases to $11 due to income earned $50.00 ($11/unit x 100 = $1,100 market value) Distribution •• NAV increase triggers a distribution (Fund distributes •• Distribution reduces the NAV/unit to $10.50 (100 units x $10.50 = $1050) $0.50/unit each year)

Final Value Option 1: Cash Option 2: Re-invest The $50 distribution gets paid out in cash, The $50 distribution gets reinvested to purchase the units you hold remain the same additional units at the current NAV of $10.50. This increases your holdings by 4.7619 units $50.00 / $10.50= 4.7619 units 100 104.7619 Unit Holdings Unit Holdings $50 $50 Received in Cash Reinvested Distribution $1050 $1100 Total Value of Portfolio Total Value of Portfolio $1100 (Cash + Portfolio Value)

For illustrative purposes only. How do mutual fund distributions work? | June 2019 | Page 6 Impact of Distributions

How distributions affect your book value

•• Book value is the amount you paid for your investments, while market value is the amount your investments are worth on a given day •• The market value of your portfolio fluctuates due to changes in the NAV of your mutual fund(s) •• Reinvested distributions are treated as new purchases and therefore impact your book value •• Cash distributions do not affect your book value.

Book Value Purchase $10/unit x 100 = $1,000 Distributions are set up to 100 units purchased at $10/unit be reinvested: Follow-up purchase: $12/unit x 100 = $1,200 100 units purchased at $12/unit

Reinvested Distribution: 100 units x $0.50 = $50.00 Fund distributes $0.50/unit each year

New Book Value: $1,000 + $1,200 + $50 = $2,250

For illustrative purposes only.

Note Book value and market value cannot be used to calculate performance. Instead, you need to compare the amount invested with the current market value. Here’s how: •• Market value of investment = $1,100 •• Amount invested = $1,000 = [(Current market value – Amount invested)/Amount Invested] x 100 = [($1,100 - $1,000) / $1,000] x 100 = ($100/ $1000) x 100 = 0.1 x 100 •• Fund Performance = 10.00%

How do mutual fund distributions work? | June 2019 | Page 7 Impact of Distributions

What happens when your book value is higher than your market value after a distribution?

If there is market close to the time a distribution is issued, it is possible that the market value of your investments may be lower than your book value, even after the distribution.

It’s important to remember that, just like a capital gain, a capital loss is not realized until you redeem your units.

ACB and Distributions

What is Adjusted Cost Base (ACB)? Distributions the following two types of distributions •• Average price paid for the units you own can affect the ACB of your mutual fund investment: 1. Reinvested distributions. •• Used to calculate whether you have a capital gain or loss when selling a mutual fund 2. Return of capital distribution. Book Value Purchase $10/unit x 100 = $1,000 Distributions are set up to 100 units purchased at $10/unit be reinvested: ACB Calculation Follow-up purchase: $12/unit x 100 = $1,200 100 units purchased at $12/unit Purchase $10/unit x 100 = $1,000 Distributions are set up to be reinvested: 100 units purchased at $10/unit Reinvested Distribution: 100 units x $0.50 = $50.00 Fund distributes $0.50/unit each year Follow-up purchase: $12/unit x 100 = $1,200 100 units purchased at $12/unit New Book Value: $1,000 + $1,200 + $50 = $2,250 ABC: $2200 = $11.00/Unit Total Investment � Number units = ACB 200 units

Per unit capital gain from sale: $15/unit - $11/unit = $4.00/unit 200 units sold at $15/unit

Total capital gain from sale: $4/unit x 200 units = $800.00

For illustrative purposes only.

How do mutual fund distributions work? | June 2019 | Page 8 Impact of Distributions

How does a reinvested distribution affect your ACB?

ACB with reinvested distributions Purchase $10/unit x 100 = $1,000 Distributions are set up to be reinvested: 100 units purchased at $10/unit

Follow-up purchase: $12/unit x 100 = $1,200 100 units purchased at $12/unit

Re-invested distribution: $50/$10.50 = 4.7619 $50 distribution at $10.50/unit NAV added 4.7619 units.

ACB: $2200 + $50 = $10.99/Unit Total Investment � Number units = ACB 204.7619 units

Per unit capital gain $15/unit - $10.99/unit = $4.01/unit from sale: 204.7619 units sold at $15/unit

Total capital gain from sale: $4.01/unit x 204.7619 units = $821.19

For illustrative purposes only.

CapitalHow do mutual fund distributions work? | JuneGains 2019 | Page 9 Impact of Distributions

Purchasing a mutual fund close to year-end. The NAV of a mutual fund will increase as income and/or net realized Note capital gains are earned and accumulated in the fund but not It’s best to speak to your yet distributed. investment professional if you plan on buying a mutual fund If you buy units of a mutual fund just before it makes a distribution, you will near year-end. It may be wise receive and be liable for tax on that distribution, even though the value of to wait until a distribution has the distribution was reflected in the unit price you paid for the fund. been made before investing.

Year-End Purchase: A TD Fund has an upcoming capital gain distribution of 5% on December 10th. Option 1: Option 2: Pre-distribution Post-distribution $1000 $1000 December 9th Purchase December 11th Purchase (100 units purchased at $10/unit) (105.26 units purchased at $9.50/unit) $50 December 10th Re-invested distribution NAV drops $9.50 NAV (New units purchased = $50/$9.50 = 5.26)

Final Portfolio Value 105.26 105.26 Total Unit Holdings Total Unit Holdings $1000 $1000 Total Value Total Value $50 $0 Taxable Income Taxable Income

For illustrative purposes only. How do mutual fund distributions work? | June 2019 | Page 10 Return of Capital Distributions

ROC distributions ROC distributions are slightly more complicated. This type of distribution typically occurs when the fund’s objective is to generate regular distributions.

Q: What is ROC? Q: ROC and taxes? As we have discussed, ROC is a part of the original Unlike other types of distributions, such as interest income investment amount or capital being returned to you by a or dividends, ROC is not taxable when received because mutual fund it’s your own money coming back to you.

Q: ROC and ACB? ROC distributions are not part of a fund’s rate of return or yield, but instead reduce the ACB of your investments. This may impact the capital gains (or losses) realized when you eventually sell your investments.

Note Your ACB can be reduced to zero, which occurs when you’ve been given back all the money invested in a fund through the ROC distributions received. If you continue to receive ROC distributions on the units you hold, these will be taxed as capital gains.

Benefits of ROC distributions:

Monthly cash flow Tax efficiency Since a fund that pays ROC aims to provide you with a Generally, ROC is not taxable in the year received (unless regular cash flow, you’ll know what income to expect which your ACB is reduced below zero). Unlike interest, dividends may allow you to plan ahead. and capital gains, ROC allows you to defer capital gains tax until you sell your investment. This flexibility can help you determine the best time to sell your investment Simplified tax reporting according to your personal situation. For example, being Details of all ROC distributions are conveniently provided in a lower tax bracket when selling your units could impact on your year-end tax slip. This simplifies your tax reporting, the tax rate applicable on all income, including realized unlike Systematic Withdrawal Plan transactions where you capital gains. must calculate taxable capital gains or losses for each redemption.

How do mutual fund distributions work? | June 2019 | Page 11 Return of Capital Distributions

Benefits of ROC distributions: Potential to minimize government Growth potential clawbacks Even though part of your original investment is being Generally, ROC distributions increase your monthly cash returned to you each month, your investment can grow, flow without increasing your taxable income. That means provided the return earned by the fund is higher than the eligibility for government programs such as Old Age Se- amount distributed. curity, the Guaranteed Income Supplement, spousal tax ACB with reinvested distributions credits and medical expense credits is not affected. Purchase $10/unit x 100 = $1,000 Distributions are set up to be reinvested: 100 units purchased at $10/unit ACB and ROC

Follow-up purchase: $12/unit x 100 = $1,200 Current ACB $1000 / 100 units = $10/ unit ACB 100 units purchased at $12/unit $1000 invested and 100 units are owned

Re-invested distribution: $50/$10.50 = 4.7619 Re-invested distribution: 100 units x $0.50 = $50.00 $50 distribution at $10.50/unit NAV $0.50/unit yearly distribution added 4.7619 units. ACB: $2200 + $50 Re-invested distribution: $50/$10.50 = 4.7619 Total Investment � Number units = ACB 204.7619 units $50 distribution at $10.50/unit NAV added 4.7619 units.

Per unit capital gain $15/unit - $10.99/unit = $4.01/unit ACB after ROC Distribution: $10.00 - $0.10 = $9.90/unit ACB from sale: 204.7619 units sold at $15/unit Original ACB must be reduced $0.40/unit is interest income by the amount of ROC received $0.10/unit is ROC

Total capital gain from sale: $4.01/unit x 204.7619 units = $821.19 Per unit capital gain $15/unit - $9.90/unit = $5.10/unit from sale:

For illustrative purposes only.

ReturnHow do mutual fund distributions ofwork? | June 2019 | Page 12 Capital Corporate Class Fund Distributions

Corporate Class Funds

Corporate Class funds are structured differently than mutual funds. In this section we will explore the differences and how they can affect the distributions you receive.

Q: What is the difference between a mutual Q: How corporate class funds distribute fund trust and a corporate class fund? to investors? A mutual fund trust is a single legal entity where interest, Since interest and foreign income earned inside of a dividends and capital gains earned in the fund are paid mutual fund corporation are taxable inside the corporate to you. structure, these funds cannot distribute interest or other Corporate Class mutual funds are structured in the form of income to you. However, mutual fund corporations can a mutual fund corporation. This corporation may consist distribute income as either capital gain dividends or eligible of different mutual funds called ‘classes’ and often holds Canadian dividends. Distributions from corporate class the same type of investments as mutual fund trusts. For funds are reported on a T5 tax slip or Relevé 3 in Quebec. example, Class A may be a Canadian fixed income fund; Class B, a U.S. balanced fund; Class C, an international fund. These funds may offset income and expenses at the corporate level, which can potentially offset distributions of the mutual fund corporation.

Note As of January 2017, switching between classes within a mutual fund corporation is considered a taxable transaction.

CorporateHow do mutual fund distributions work? | June 2019 | Page 13 Other Considerations

Distributions - Other considerations •• Funds may distribute income and issue a tax slip even if its return for the year is negative. This is similar to a or bond that pays dividends or interest when its market value has declined. •• Distributions received in your non-registered investments are taxable and will be reported on your T3 or T5 tax slip, whether you receive them in cash or reinvest them in additional units of the fund. Unless you advise us otherwise, distributions on TD Funds are automatically reinvested in additional units.

Summary There are several types of mutual fund distributions, each of which may be taxed differently. Understanding what distributions are, the unique characteristics of each type and how they are taxed can help inform your investment decisions and contribute to your ability to reach your financial goals.

For more information about distributions and the taxation of distributions, please speak to your Financial Planner or Advisor or a qualified tax specialist.

The information contained herein has been provided by TD Asset Management Inc. and is for information purposes only. The information has been drawn from sources believed to be reliable. The information does not provide financial, legal, tax or investment advice. Particular investment, tax, or trading strategies should be evaluated relative to each individual’s objectives and risk tolerance. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the fund facts and prospectus, which contain detailed investment information, before investing. Mutual funds are not guaranteed or insured, their values change frequently, and past performance may not be repeated. A return of capital (ROC) distribution reduces your adjusted cost base. This could lead to a higher capital gain or a smaller capital loss when the investment is eventually sold. If your adjusted cost base goes below zero you will have to pay capital gains tax on the amount below zero. The payment of ROC distributions should not be confused with a fund’s performance, rate of return or yield. TD Asset Management Inc. is a wholly-owned subsidiary of The Toronto-Dominion Bank. All trademarks are the property of their respective owners. ® The TD logo and other trade-marks are the property of The Toronto-Dominion Bank

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